Why Barriers Went Up, And How They Fell

October 23, 1999|By KENNETH R. GOSSELIN; Courant Staff Writer

The last barriers separating the traditional three segments of financial services -- banking, insurance and securities -- have all but tumbled down, now that a historic agreement has been reached in Congress.

For two decades, federal legislators have grappled with reform. In recent years, the courts and regulators have chipped away at decades-old laws, letting banks deeper and deeper into the long forbidden territory of insurance sales and securities underwriting.

The sweeping reform, which is expected to pass both houses of Congress and be signed by President Clinton, is long overdue and is expected to make U.S. financial services firms more competitive with counterparts in foreign countries, observers say.

Those foreign competitors have long offered customers banking, insurance and securities -- all under one roof.

But why were the laws established in the first place? And what has changed in the decades since?

The Depression-era Glass-Steagall Act, enacted after the 1929 stock market crash, was intended to keep bankers and securities underwriters out of each other's businesses. The law, passed in 1933, restricted how much revenue banks could derive for securities underwriting -- at first just 5 percent.

Glass-Steagall also set a tone for financial services that resonated for years: Big is bad.

Banks and brokerages took much of the blame for the country's economic woes in the 1930s, though historians would later observe that plunging real estate prices and loan defaults were as much, if not more, responsible.

By building high walls between banks and securities underwriters, federal legislators envisioned wiping out potential conflicts that could ultimately place a bank's health -- and depositors' money -- at risk.

A bank underwriting a company's stock offering, for example, might be under pressure to lend the company more money, even if the company's balance sheet got shaky.

The other law, which strengthened Glass-Steagall, is the Bank Holding Company Act of 1956. The act restricted holding companies owning banks from getting into businesses that weren't closely related to banking, chief among these insurance.

Congress' real fear was not so much that banks would act as agents in the sale of insurance but that they would begin taking on risk by underwriting policies, said Robert M. Taylor III, a lawyer specializing in regulatory law at Day Berry & Howard in Hartford.

So why have the fears lessened over time?

After Glass-Steagall was passed, the Federal Deposit Insurance Corp. began insuring bank deposits, and the Securities and Exchange Commission was formed to police public corporations, Taylor noted.

While big is not necessarily considered better in the 1990s, it does mean that a financial services conglomerate can compete in the global marketplace, experts say.

Glass-Steagall critics have long complained that the laws have hampered the growth of an international financial services powerhouse headquartered in the United States, giving institutions abroad the edge.

Over the years, the barriers erected by Glass- Steagall have been punctured by the courts and regulators. Banks can now draw up to 25 percent of their revenue from securities underwriting, and banks can now sell -- but not underwrite -- all kinds of insurance and annuities.

Last year, the Travelers-Citicorp merger pushed the envelope, hooking up banking with insurance and securities underwriting. But the permanence of the merger that created Citigroup depended on the repeal of Glass-Steagall.

U.S. Rep. James Maloney, D-5th District, said the reform measures got a strong boost this year because all three industries -- banking, insurance and securities -- agree that changes must be made if the United States is to successfully compete in a global marketplace.

``The institutions are not only ready to move, the Citicorp-Travelers merger is an example of an institution being ahead of where the law is, pushing the legal changes,'' Maloney said.